What is a life insurance policy cash value?

Life insurance policies are a great way of protecting your finances. In fact, some life insurance policies also come with an additional ‘cash value’ feature. One portion of the premium paid goes into risk coverage (insurance) and the other portion goes into cash value, which acts as your savings. As the years go by, the policy ages, and the cash value earns interest. Economic surveys reveal that India’s life insurance penetration for the year 2019 was a mere 2.82%. This percentage would considerably improve if people saw insurance policies as a cash source, and investment as well.

As mentioned earlier, simple term insurance policies do not have cash value. Cash value is a specific feature of permanent life insurance policies. Before we get into permanent life insurance policies, and the cash value they provide, let us look at why term plans in India do not have cash value. The simple answer is that term plans are a purely risk coverage or insurance policy, no portion of the premium is set out for savings. To ensure that the policy holder gets maximum coverage, it is important that the entire premium amount is dedicated towards insurance. The premium paid towards term plans are therefore much lesser than that paid towards permanent life insurance policies. This affordability is why term plans are hugely popular in India.

As discussed above, permanent life insurance policies are those that afford protection for the entire lifetime of the policy holder, and double up as a means for savings in addition to being an insurance policy. The major types of permanent life insurance policies in India are as under.

Whole life policies are the most commonly found permanent life insurance policies in India. It provides the policy holder with benefits until the end of their lifetime, and also provides policy holder with retirement benefits. There are three types of whole life insurance policies, as given below.

Here, premiums are paid until the policy holder’s demise and benefits are received after such demise.

Here, premiums are paid until a fixed period as chosen by the policy holder, the cover however, remains for life.

It is the life insurance policy that most salaried employees in India have. These policies afford protection for a specific period of time. After the expiry of this period, the policy holder has the option to discontinue with the policy or to extend the same or receive maturity benefit. In the event that the policy holder passes away during the subsistence of the policy, the nominee receives the policy amount along with a bonus, depending on the number of years for which the policy has been in existence. The same is also received upon maturity of the endowment policy.

Of the numerous benefits of permanent life insurance policies, some of the most important ones are listed below.

Permanent life insurance policies provide financial protection for the entire lifetime of the policy holder. The cover will not be cancelled even upon diagnosis of illnesses, however critical, so long as premiums are regularly paid.

The general notion is that premiums rise exponentially as the policy ages couldn’t be farther from the truth. The premiums remain stable across the entire duration of the policy.

A part of the premium paid towards permanent life insurance policies is kept aside as savings (cash value) and interest is earned on this cash value as the years go by. This can be tapped into in the event of a financial emergency.

Policy holders of permanent life insurance policies have the option to use the cash value and access it flexibly. It can be withdrawn, or loans may be taken against the cash value to procure emergency funds.

The premiums paid towards your permanent life insurance policies can be availed as a tax deduction under Section 80C of the Income Tax Act, 1961. The death benefit received under these policies are also exempt from taxation under Section 10(10D) of the Income Tax Act, 1961. However, tax benefits are as per current tax laws, and are subject to change from time to time.

Given below is a list of situations where it is best to buy a permanent life insurance policy, over term life insurance policies.

The following factors influence the cash value of life insurance policies.

If you want to know what the cash value of your life insurance policy is, at present, all you have to do is ask the insurance service provider.

Using insurance policies as means to procure cash is a practice that is followed across the globe. There are many reasons why insurance is often preferred as a cash source. Some of the most commonly found reasons are given below.

Nobody can predict the future and health of humans. While insurance policies provide cover in the event of medical emergencies, permanent life insurance policies will help you procure cash required for the expenses that wouldn’t be so covered.

The cash value of permanent life insurance policies act as a form of corpus towards the future. You save up a portion of the premium paid, and can reap the benefits to meet expenses after retirement.

Palliative care and hospice expenses are not always completely covered by health insurance policies. In such cases, the cash value of your permanent life insurance policy can be tapped into for money.

When your policy outlives its purpose, all the premium you’ve deposit over the years does not need to go unused, the portion of premiums that go towards cash value may be used to meet needs that may arise in the future.

As is clear from the above list, life insurance policies are preferred as a cash source mostly when unexpected emergencies or tough times arise in life.  Always be prepared for these unexpected emergencies by verifying the cash value of your life insurance policy.

Now that you know that life insurance policies are a great investment and source of cash during emergencies, let us look at how you may access this cash value. Each policy has its own terms and conditions for how to access cash value, given below are some common ways.

The most common way in which to access cash value in life insurance policies is by making withdrawals. A portion of the premium paid is reserved as savings and earns interest over time. The cash value amassed can be withdrawn when the need arises.

Another way through which you can access the cash value in life insurance policies is by taking out loans against the cash value of the life insurance policy. The loan value is dependant on the type of policy, but typically a loan that amounts to up to 90% of the cash value may be taken. When a life insurance policy is the collateral, the interest on loan taken is also much lower.

Cash value is a component of some types of life insurance. This is a feature that’s typically offered within permanent life insurance policies, such as whole life and universal life insurance.

Policyholders can use the cash value as an investment-like savings account and take money from it.

While buying cash value life insurance may seem like a smart choice, it’s not always the right one. Here’s what you need to know about cash value life insurance.

Cash value life insurance is a policy that contains a cash value account. This cash value component typically earns interest or other investment gains and grows tax-deferred.

You have several options if you want a cash value life insurance policy. Each policy type accrues cash value differently, but in all cases, you can get to your cash value through a loan, withdrawal or surrender. Here are five types of cash value life insurance.

Whole life insurance is a type of permanent life insurance that’s possibly the simplest cash value policy. Whole life insurance policyholders don’t have to decide on how the cash value should be invested. The insurance company provides a fixed rate of return to grow the cash value.

Here’s a summary of whole life insurance:

Guaranteed issue life insurance is a type of whole life insurance. You can’t be turned down, and the application process has no medical exam or health questions. These whole life policies are sometimes referred to as burial insurance, funeral insurance or final expense insurance.

Universal life insurance policies are the most common cash value life insurance policies. Not all types of universal life build cash value well, so make sure you understand what you’re buying if you’re looking for cash value growth.

Let’s dig deeper to show the difference among universal life insurance types.

Guaranteed universal life insurance

Indexed universal life insurance

Variable universal life insurance

Premium payments for cash value life insurance go three places:

So only a portion of what you pay winds up in cash value.

You can withdraw money from cash value or take a loan against it and use the money for anything you want. That could be for an emergency, supplementing retirement income, and paying premiums. There’s no limit to how you can use cash value.

You can also take your cash value if you decide to end the policy. If you terminate the policy with the insurer, you receive the cash value amount minus any surrender charge. This action ends the life insurance coverage.

There is typically a surrender charge if you terminate the policy within the first several years after buying it. The surrender charge is a way for the insurer to cover the cost of issuing you the policy.

If you build up enough money in your cash value account, you may be able to use your cash value to cover premium payments. If you’re struggling to make the payments, this option could provide some relief so that you can keep the life insurance in force.

If you drain all the cash value from the account, the policy could lapse, so be aware of your cash value level.

Talk with your insurance company to find out their rules for using cash value toward your premiums.

You can tap into a policy’s cash value while you’re alive with the methods below.

You can borrow against the cash value of a permanent life insurance policy. Your loan amount accrues interest until it’s paid back in full.

The interest on a policy loan may be fixed or a variable rate that’s calculated by the insurer based on current market rates.

State law often dictates the maximum policy loan interest rate. For example:

If you don’t repay the loan amount and you pass away, the insurance company subtracts the outstanding loan balance (including interest) from the life insurance payout to your beneficiaries. Some policyholders choose to use their cash value this way and intend for their beneficiaries to get a reduced payout.

Another perk to a policy loan is that it doesn’t appear on your credit report.

It’s also possible to take withdrawals from your policy. If the amount you withdraw includes investment gains, often referred to as the part “above basis,” that portion is taxable. As with taking a policy loan, making a withdrawal reduces the life insurance payout to your beneficiaries later.

Surrendering an insurance policy means you’re canceling the coverage. When you surrender a policy, you can get back the cash value minus any surrender charge.

The insurance company also subtracts any unpaid premiums or outstanding loan balance. Still, getting some money back is better than simply walking away from the policy empty-handed if you no longer want it.

Whether cash value life insurance is right for you depends on why you want a policy. Here are the benefits of a cash value life insurance policy.

Cash value life insurance is a permanent life insurance policy, which means it can remain in effect until you die as long as you pay your premiums. If you take loans or withdrawals from the policy, you also have to make sure you maintain a minimal cash value level or your policy could lapse.

If you want to make sure your loved ones get something, a cash value policy is likely the better option than term life insurance.

Many whole life insurance policies are “participating,” meaning the policy owner can potentially get dividends if the policy is from a mutual insurance company.

Dividends can be:

Dividends can also be used to buy “paid up additions” to your life insurance policy, which increases the death benefit amount for beneficiaries.

Having a participating policy is a way to lower your overall life insurance cost.

Most types of life insurance have options for adding policy riders that tack on extra coverage or features. One of the most common life insurance riders is an accelerated death benefit, which is often automatically included. This gives you access to your own death benefit while you’re still alive if you’re diagnosed with a terminal illness. It can be useful for paying medical bills and other unexpected costs.

Similar riders for chronic illness and long-term care also let you tap into your death benefit if you have certain medical conditions. Your life insurance agent can tell you the rider options available with your policy before you buy it.

There can be several tax advantages to purchasing life insurance and, specifically, a cash value life insurance policy. A primary tax perk is that your beneficiaries receive the death benefit tax-free, as with any type of life insurance. Since life insurance payout amounts can be pretty large, this is an important advantage.

Another tax advantage is that the total cash value accumulates on a tax-deferred basis. So as your cash value grows, the IRS doesn’t take a cut.

Also, if you borrow money against the policy, you won’t have to pay taxes on the loan, just as you wouldn’t pay taxes on a personal loan. The loan isn’t taxable as long as the policy is in-force.

If you withdraw cash value or take the surrender value and terminate the policy, you can be taxed on the portion of the money that came from interest or investment gains.

Therefore, it’s important to understand tax rules before taking out money so you don’t get hit with a surprise tax bill.

Cash value life insurance isn’t for everyone. Here are some potential negatives to cash value life insurance.

Cash value insurance costs more than term life insurance.

If you need life insurance because you want to cover a specific debt or a certain amount of time, look at term life insurance. It doesn’t offer a cash value component, but it will pay out a death benefit amount of your choice if you pass away while the policy is in force.

Term life insurance is ideal for covering the years you’re paying a mortgage or the years until your children are expected to be financially independent. And it won’t cost you an arm and a leg like some forms of cash value life insurance, such as whole life insurance. If you don’t need insurance for the duration of your life, term life insurance will give you the most coverage bang for your buck.

Many term policies also let you convert term life to permanent life insurance later.

Life insurance is designed as a financial safety net for your loved ones if something happens to you. While cash value life insurance may seem enticing, it doesn’t make sense to pay the higher price tag if you don’t need insurance indefinitely.

Related: Comparing Term Life Vs. Whole Life Insurance

Some policies take a long time to build up any significant cash value. You could wait decades before you have a substantial amount to access. There are some life insurance policies designed for faster cash build up in the early years of the policy. Work with an experienced life insurance agent who can guide you toward the right products.

When you pass away, cash value typically reverts to the life insurance company. Your beneficiaries receive the policy’s death benefit amount, minus any loans and withdrawals of cash value you made. That said, there are some policies that will pay out the death benefit plus cash value to beneficiaries, but be prepared to pay substantially more for this feature.